Whether you’re buying a car, selling your restaurant or signing a property lease, you have to sign a contract. As a VAT consultant, I’m often asked to review contracts and VAT clauses, so over the years I’ve spent a lot of time reading contracts to see whether the VAT clauses are reasonable in those particular circumstances. One of the most common scenarios is being asked to review the VAT clauses on a 200 page asset sale contract at about 4pm on a Friday afternoon when the solicitors need to complete the deal by close of business. Not always an easy task. Dealing with VAT clauses in contracts can actually be quite complicated and it’s not always easy to meet the interests of all of the parties involved.
So what exactly should be included in VAT clauses?
Well, the answer isn’t really a VAT issue. It’s simply that the parties have to agree how to bear the potential risk of any VAT assessment, penalties, interest and other costs that may arise as a result of an error made by one of the parties; or because one of the parties has not provided the correct or full information. Either way, there’s no definitive set of rules: the solicitors will be aiming to get the best result for their respective clients and the VAT interests of either side will depend on the nature of the transaction.
However there are two main issues to consider: the type of transaction involved and the VAT profile of the parties involved.
Taxable sale: bespoke software
Let’s consider how things would differ if a software company was designing bespoke systems for a manufacturer on the one hand and a bank on the other hand. The manufacturer only makes taxable supplies (i.e. sales that are liable to VAT) so can claim VAT on purchases while the bank makes mostly exempt supplies and can’t claim VAT on purchases.
In both cases, both parties should insist on “basic” VAT clauses that establish that the net price is VAT exclusive and that VAT at the appropriate rate (in this case 20%) will be added to the net price. The purchaser will only pay the VAT if the supplier issues a proper VAT invoice.
Both purchasers should also require a clause that says that they will not pay VAT if HMRC should rule that the sale was not liable to 20% VAT; whether because the sale was liable to a different VAT rate (5% or 0%) or exempt from VAT.
Of course, this makes sense from the bank’s perspective because any overcharged VAT is simply extra cost. However it’s just as important to the manufacturer because VAT registered businesses can only claim VAT if it is correctly charged. This is not only a matter of law, but HMRC regularly review input tax claims and will issue assessments for incorrectly charged VAT even if the purchaser is a “fully taxable” business.
Property transactions
Most of you will appreciate that when it comes to property transactions, things become particularly complicated because of the complexity of the VAT rules about property transactions. Two of the most common situations are the sales of opted tenanted properties as going concerns and the exempt sale of properties where the purchaser has directed the vendor to “disapply” the option to tax by issuing a VAT 1614D certificate.
The VAT liability of each of these transactions depends almost entirely on the purchaser carrying out certain actions at certain specific times – in the case of the tenanted property, by making and notifying HMRC and the vendor of his option to tax before the “relevant date” (VAT Notice 700/9: Transfer of business as a going concern; section 2.4 http://tinyurl.com/oskp9zz) – and in the case of the disapplication of the option to tax by issuing the VAT 1614D certificate to the vendor before the price is “legally fixed” (VAT Notice 742a: Opting to tax land and buildings; section 3 http://tinyurl.com/qbrewhq).
I have seen VAT clauses for particularly complex transactions, such as the sale of large property portfolios or business mergers, that run to pages and pages of text, all of it important to one or both of the parties involved. But whatever type of transaction, you need to ensure that potential VAT risks are properly covered. Ask your VAT consultant to help identify potential risks and work with your solicitor so that the issues are included in the contract. It’s a good idea, for example, to include some provision for appealing against assessments or decisions relating to the transaction issued by HMRC to help manage what could otherwise be a very difficult set of circumstances.
VAT liability, penalties, interest, costs, expenses: how long is a piece of string?
The other issue is how to deal with potential VAT costs that arise because of an error by one of parties. For example, a purchaser could issue a VAT 1614D certificate on the basis that it intends to convert a commercial property into a dwelling. However HMRC subsequently discover that the purchaser never intended to convert the property but to sell it as a development property so the VAT 1614D didn’t apply.
In these circumstances, the vendor would have to charge VAT and pay it to HMRC, plus there may be penalties to pay as well as legal costs or other expenses.
Of course it’s important that the risk is borne by the party who makes the mistake and causes the VAT liability and other costs to arise. This is normal practice in any transaction and solicitors have to identify any risks and ensure that their client’s position is protected. But this aspect of the contract is like any other part – it’s up for negotiation between the parties. For example, I’ve seen draft VAT clauses which include wording such as “any and every cost incurred.”. This seems somewhat open-ended to me. Who decides what sort of costs should be included? Should there be some sort of cap on such costs?
There are potentially a lot of VAT related issues for even the most straight-forward transaction. But either way, remember that the VAT is one aspect of the transaction as a whole and you can negotiate about the contents of the VAT clauses just the same as anything else. For example, you might agree to accept some sort of mediation for VAT disputes in return for a reduction in price or better payment terms. It’s all there for the taking.
Marie
February, 2017